Debt: What It Is, How It Works, Types, and Ways to Pay Back
Most people out there struggle with debt. If you are one of them, you should have a clear idea on what it is all about and how you can get out of it. This knowledge will be useful for anyone who is planning to get under debt as well. Continue to read and we will share all information you need to know about debt.
What Is Debt?
Debt is money that is owed to a lender. It is created when an individual, business, or government borrows money. The borrower gets access to immediate funds and agrees to pay back the amount borrowed over time, often with interest. Debt allows consumers and businesses instant access to money to make purchases or investments now and pay for them in the future.
Some common types of debt include mortgages, auto loans, student loans, and credit card debt. Debt is typically categorized as either secured or unsecured. Secured debt means the loan is backed or secured by collateral, such as a house in the case of a mortgage. Unsecured debt has no underlying assets attached to the loan and carries more risk for the lender.
How Debt Works
When a lender issues debt, it is effectively lending money to be repaid in the future with interest. The lender charges interest as compensation for not having access to those funds during the borrowing period. The interest rate charged depends on factors such as the length of the loan term, borrower’s creditworthiness, and overall interest rate environment.
The borrower who takes on debt commits to make regular repayments of interest and principal back to the lender over a set time frame. Repayment schedules can vary significantly by debt type. Mortgages may have repayment periods of 15 or 30 years. Credit cards have minimum monthly payments, but the full balance can take years to pay off if only minimums are made. Paying the minimum due on debts will increase overall interest costs over the life of the loan. Paying more than the minimum helps pay off debt faster and reduces interest expenses.
Making timely payments is critical when managing debt. Missing payments can result in late fees and increased interest rates. Severely delinquent debts may be sent to collections agencies. Nonpayment can also damage credit scores, which can limit access to additional credit. Successfully repaying debts builds positive credit history and improves creditworthiness over time.
Types of Consumer Debt
There are several common types of consumer debt that individuals take on for different borrowing needs:
- Mortgages: Long-term loans for purchasing real estate. Mortgages require a down payment and payments are made monthly over 15 to 30 years. Interest rates are fixed or adjustable. Mortgages are secured debt backed by the real estate being purchased.
- Credit Cards: Revolving lines of credit that can be used to make purchases. Credit cards have variable interest rates and minimum monthly payments. Balances can be carried from month to month subject to interest. Credit card debt is unsecured.
- Auto Loans: Short to medium-term loans for purchasing cars. Auto loans run 2 to 6 years with monthly payments. Interest rates can be fixed or variable. Auto loans are secured debt tied specifically to the car purchased.
- Student Loans: Long-term loans to pay for higher education. Federal student loans have fixed rates, while private lenders offer variable rates. Loans have several deferment and repayment options. Student loans are typically unsecured.
- Personal Loans: Fixed-rate instalment loans that provide lump-sum amounts. Personal loans have terms of 2 to 7 years with monthly payments. Interest rates are set based on credit score. These are unsecured obligations.
- Payday Loans: Very short-term loans requiring a single lump-sum repayment with interest. Payday loans charge extremely high interest rates and fees, creating debt traps. These predatory lending practices target low-income individuals.
Why Is Being in Debt Bad?
Carrying excessive debt can negatively impact individuals and households in several ways:
- Reduced disposable income due to required debt payments
- Accumulation of interest charges increases total cost of borrowing
- Potential for late fees and penalties due to missed payments
- Risk of default if unable to manage repayment schedule
- Harm to credit score and ability to access additional credit
- Added stress from financial obligations and uncertainty
- Limited flexibility due to allocating income to debt payments
- Impact on ability to achieve other financial goals like saving for retirement
However, not all debt is bad. Reasonable amounts of debt used wisely, such as mortgages and student loans, can provide opportunity. The key is maintaining manageable levels of debt and leverage based on income.
How to Get Out of Debt
Individuals struggling with excessive debt have options for regaining financial stability:
- Budget to increase cash flow available for repayment
- Prioritize paying down highest interest rate debts first
- Consider balance transfer offers to consolidate higher rate balances to lower rate cards
- Communicate with creditors to negotiate modified payment plans or rates
- Explore debt management programs that facilitate repayment
- As a last resort, declare bankruptcy to eliminate certain qualifying debts
- Seek credit counselling for customized guidance on managing severe debt
The path to becoming debt-free also requires changing habits and behaviors. Steps to prevent incurring further unmanageable debts include:
- Spending less than you earn
- Building emergency savings
- Avoiding impulse purchases and shopping with intention
- Saying no to requests for money you cannot afford
- Finding less expensive alternatives like buying used items
- Being a mindful consumer and resisting constant upgrades
- Monitoring your credit report and scores regularly
- Taking advantage of loyalty programs and discounts
- Cooking meals at home more often
- Downsizing housing, vehicles, or other major expenses
- Finding additional income sources through part-time work or monetizing skills
Managing debt requires diligence, restraint, and focus. But millions have overcome challenging financial circumstances and gone on to achieve brighter futures by taking control of their debt. With practical steps and shifting mindsets, you too can get out of debt and unlock greater stability.
What happens to unpaid credit card debt in the Philippines
In the Philippines, unpaid credit card debt is considered delinquent after 90 days of nonpayment. Credit card issuers are required to charge-off delinquent balances after 180 days as mandated by the Bangko Sentral ng Pilipinas (BSP). This means the bank removes the unpaid debt from its books as an asset and records it as a loss.
The credit card account is closed, and no further transactions are allowed. The account holder’s credit score is negatively impacted. Banks continue collection efforts on charged-off debts through letters, calls, and engagement of third-party collection agencies. However, they rarely pursue legal action in court.
After charge-off, banks have the option of selling the bad debt to collection agencies at a steep discount. The buying agency then continues collection activities and pockets any amounts recovered. Data shows only 4-5% of bad debts are ever collected in the Philippines.
A 7-year delinquency clock starts from the point of last payment. After 7 years of no payments, the debt is written off and legally uncollectible under the Philippines’ Statute of Limitations. However, credit reporting of the default can remain for longer. Settling or paying the debt, even partially, restarts the 7-year clock.
Filipinos view credit card debt as low priority and frequently walk away from balances. With low legal risks and no wage garnishment, consumers carry little incentive to repay. This cultural norm around credit card debt leads banks to be conservative with credit limits and strict with approvals.
What Is the Difference Between Debt and a Loan?
While debt and loans are often used interchangeably, there are some key differences:
- Debt – A general obligation to repay money borrowed from a lender. Debt can arise from loans but also through unpaid bills or interest charges.
- Loans – A specific lending agreement where a lender provides a lump sum up front to a borrower who agrees to repay it over time. Loans usually have defined terms for repayment periods, interest rates, and collateral.
Read too: Investments for beginners – See how to get started in the world of investments!
How to Pay Off Debt
Paying off debt requires discipline but can be accomplished with some practical strategies:
- Take an inventory of all debts and due dates so you have full visibility
- Make a budget to optimize cash flow to devote to debt repayment
- Prioritize paying off high-interest credit cards first to reduce interest costs
- Consider balance transfer offers to consolidate credit card balances to lower rates
- Use windfalls like bonuses or tax refunds to make extra debt payments
- Communicate with creditors to negotiate modified payment plans if needed
- Avoid taking on new debts during the repayment period
- Get guidance from nonprofit credit counselling agencies
- Consider debt management programs that negotiate rates and consolidate payments
- Evaluate options to refinance high-interest loans to more favorable rates
- Boost income with overtime hours or part-time work to put more toward debt
- Cut discretionary expenses like dining out or vacations during the debt repayment term
- Sell assets that aren’t essential to pay down balances faster
- Once debts are paid, build emergency savings to avoid future debt reliance
Final words
The road to zero debt requires sacrifice and hyper focus on the end goal. But perseverance and a debt payoff plan can help motivated individuals eliminate unsecured consumer debts in as little as 12-24 months. The journey not only leads to financial freedom but builds character, resilience, and skills to live debt-free for good.
